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How Shanghai’s Free Trade Zone Works

By Caixin staff reporter Hu Shuli. This article was first published by Caixin.

At a conference table surrounded by bookshelves in his Shanghai office, the city’s party boss Han Zheng recently polished the image of a commercial crown jewel—the China (Shanghai) Pilot Free Trade Zone—during an exclusive interview with Caixin.

Han described the planning, politicking, and far-reaching goals for the FTZ one month after the zone project officially launched September 29 in China’s biggest city.

Financial and administrative procedures are to be tested inside the twenty-eight-square-kilometer zone as a bellwether for further economic reform in China. Ground was broken for the experimentation one day after the launch, when the Shanghai government released the zone’s “negative list” of businesses, including Internet cafes, lotteries, news organizations, and social surveys that FTZ investors may not pursue.

Any type of commercial or financial pursuit not on the list is fair game inside the zone and can start without government approval as long as the authorities are informed.

Some investors and economists lamented over the length of the no-go list and the FTZ’s 190 special regulatory measures, which will apply to nearly eighteen percent of industrial sectors in China.

But the FTZ’s architects built a system that balances commercial innovation and risk control, Han said. And fine-tuning will continue for at least another three years during the zone’s phase-in period.

“FTZ is part of a national strategy, a key decision that deepens reform, a breakthrough that overcomes the main obstacles to reform,” Han said. “With this breakthrough, the government’s role can undergo major changes. It can also boost scientific development and increase China’s competitiveness.”

What led to the FTZ’s launch, and what sorts of innovations can be expected in the future? Han, a fifty-nine-year-old Politburo member, provided answers without a script during the Caixin interview, excerpts from which follow.

Caixin: What’s the FTZ blueprint?

Han Zheng: Establishing the FTZ was a breakthrough accomplishment. No favorable policies were involved. The FTZ is based on an innovative system and personally motivated innovation. It's also market-oriented and lets the market play a true role in resource allocation through a more comprehensive market mechanism.

The core reform was to transform the government’s role. This is not a slogan. The most important task now involves reforming the administrative review system. The current review and approval system is unreasonable in many ways. Many review steps conflict with the market and international norms, impairing efforts to improve China’s level of international competitiveness.

The FTZ’s innovative system is a move toward establishing a market economy and integrating it with international rules. In the process, we need to give ample consideration to China’s characteristics, rather than simply copy from others.

What the FTZ does is to build an innovative system and mechanism that’s replicable. Our task is to introduce innovations that can be applied in other areas around the country.

What concrete steps will be taken?

Han: We will facilitate trade and investment. The first step involves reforming investment, with a focus on breaking up the current review and approval system. We need to make the system more open and convenient, to open it before foreign investment arrives. This is a disruptive system design. We will explore, by means of publishing a “negative list” released by the government, a way to tell companies what they should do. Other decisions, such as how to do it, are for the companies to decide and do not involve government reviews. This is the so-called “negative list process.”

This change is unlike the government’s old business management method. In the past, companies did not know what they could do and what they couldn't do because things were always changing. They submitted an application, and then came a review, and then an economic benefit review. Why should the government regulate this? A private company makes money by investing overseas, so why should it report to the government? Many previous reviews were unnecessary. So we need the negative list and rational decision-making before a company opens for business. And the FTZ has become the first government entity with a negative list since the People’s Republic of China was established in 1949.

The list is similar to the investment catalogue published by the National Development and Reform Commission, isn’t it?

Han: At least the review process is different. Moreover, this is the 2013 version, and we will start garnering consensus for how to manage the negative list. Then we will have the 2014, 2015, and 2016 versions. The National People’s Congress gave us three years. We will make progress every year, making gradual improvements.

During the process, will the number of items be trimmed?

Han: That could be done gradually in 2014, 2015, or 2016 as we follow the path. This is an easier way to build unity. It might seem reasonable to do things now that should be done in 2016, but in reality such a process would not last. It’s taken a lot of work to get to where we are today, thanks to support from the president, premier, central committee, and State Council, as well as various government agencies.

This is a major, innovative reform. It frees companies from reviews. Companies used to register with the local bureau of industry and commerce in several different categories. But now there is only one category. We have realized the value of a “register first, approve later” process in the FTZ, which means companies can start operating after registration, and applies to government licensing or approvals only when they deal with the businesses required under such procedures.

Under previous rules, at least a month passed between the time a company submitted all required materials and got its business license. And a month-long process is fast, since it’s hard to get everything ready. Now it takes a few days. You register and then get all kinds of licenses, rather than getting all the licenses before applying for a registration as in the past. What your product would look like is a question for later, after you finish the registration.

How will the FTZ treat investments from monopolistic state-owned companies?

Han: Simple—national treatment (means treating foreign and domestic companies equally) before admission. The system is completely transparent. The government will not have treatments because all companies are completely equal. The process is transparent and follows all laws. There is no room for murky transactions.

Can you tell us what was behind the decision to launch the FTZ?

Han: The deliberations took about a year. At first, the plan wasn’t very big. We just wanted to explore whether Shanghai could lead the way in facilitating investment and using innovation to advance restructuring, and how Shanghai could become an international financial and trade center. The research deepened, and it was connected to some nationally strategic needs. The connections expanded, and at one point we felt that our direction was correct, our research valuable.

After the Eighteenth National Congress of the Communist Party (in 2012), our research led to a preliminary plan, which resembles the plan we have now. There are differences between research results and a real plan, which needs direction, goals, and guidelines.

At the National People’s Congress in March, General Secretary Xi Jinping participated in a discussion that included delegates from Shanghai. We took the opportunity to give him a report on the plan, and he affirmed it.

Then on March 28, Premier Li Keqiang came to the Yangtze River Delta on his first field trip since taking office. After he arrived at Shanghai, he received direct reports from members of the municipal party standing committee and government. They received his affirmation. The premier said he thought the plan was in line with national strategy.

These recognitions from the president and premier encouraged us. They said they hoped Shanghai would finish the plan as soon as possible, and then submit it to the Party central committee and State Council. We took these steps. During the process, we also reported to the leaders of the State Council who are directly in charge of this, including Executive Vice Premier Zhang Gaoli and Vice Premier Wang Yang. We also reported to relevant departments on the State Council, and received their support as well.

If the deliberations took an entire year, when did the process start?

Han: At the beginning of 2012, when Secretary Yu (Yu Zhengsheng, then-Shanghai Party Secretary, currently a Politburo Standing Committee member and Chairman of the National Committee of the Political Consultative Conference) listened to a special report about the FTZ. He gave it his full support. He stressed that the reform would be meaningful only if it were enacted with systemic and institutional innovation.

How many departments under the State Council were involved in drafting the plan?

Han: The People’s Bank of China, China Securities Regulatory Commission, China Banking Regulatory Commission, China Insurance Regulatory Commission, National Development and Reform Commission, Ministry of Finance, Ministry of Commerce, General Administration of Customs, State Administration of Industry and Commerce, and the General Administration of Quality Supervision, Inspection and Quarantine. These were directly related. There are many other agencies involved in one way or another, such as some agencies under the Legislative Affairs Office of the State Council that helped us substantiate, fine-tune, and improve the plan during our discussions. We had very close cooperation.

Did you go to Beijing often?

Han: (Shanghai) Mayor Yang (Yang Xiong) and I led a team that reported to relevant central government departments. The deputy mayor also took a team and reported to relevant departments. Because trade is central to the plan, we had a working group set up with a dual-head arrangement, headed by both the commerce minister and Shanghai mayor. Many heads of departments under the Shanghai municipal government also had face-to-face discussions with relevant central government department officials. Central government officials gave us a lot of guidance, and provided valuable suggestions for us that helped us finalize the plan.

The FTZ was originally called in the report “Shanghai Free Trade Zone.” The word “China” was added to its name given by a key member of the State Council during a regular cabinet meeting in July. The State Council thus decided to call it China (Shanghai) Free Trade Pilot Zone. We studied this decision and interpreted it as a nationally strategic move based on a pilot project that still needed work.

During the preparation period, General Secretary Xi made time for us and listened to our report again. In early July, another discussion about it was held during a regular meeting of the State Council, and in July yet another discussion was held during a Politburo meeting. A decision was reached very quickly, and with an approval from the top. Without a direct push from the party central committee, the State Council, the general secretary, and the premier, it would not have happened so quickly.

On August 30, the standing committee of the National People’s Congress passed a decision called “Authorizing the State Council the Right to Temporarily Adjust Laws and Regulations Related to Administrative Approval at the China (Shanghai) Free Trade Pilot Zone."

I heard the premier once asked you, “Do you want policy or reform?” Is that true?

Han: It is. When the premier was in Shanghai on March 28, Mayor Yang Xiong and I gave him a report. He listened and felt that what we described was an innovative system. He said, “So let’s not talk about favorable policies, but only about a system of innovation. Is that what you think?” And I answered “yes.”

My attitude was: Whatever experiment the state asks us to do, we will spare no effort to explore and try to make it work. Whatever the state asks us not to do, we won’t do at all.

What’s there not to do? I made three suggestions on March 28: ban smuggling, ban tax fraud, and ban prostitution, gambling, and drugs. If people think they can open casinos or provide prostitution services here, that will be the end of it. Nothing can involve ideological issues. We made it clear to the central government that the aim was to explore economic system reform and administrative management reform, to explore something that could be replicated and expanded elsewhere.

I can say the whole city of Shanghai shared a clear goal, definitive guidelines, and focused on the same breakthroughs. I’m very confident. We will track it every quarter, and make an assessment every half-year. We were given only three short years. It will pass in the blink of an eye. We need to hurry.

Are all innovations limited to the twenty-eight square kilometers? Will this directly involve Shanghai’s ambitious strategy to build four international centers for the economy, financing, trade, and shipping?

Han: All policies designated for the FTZ are limited to the twenty-eight square kilometers. We would need authorization from the central government to apply them elsewhere. Within the zone, there will be system innovation related to building these centers, especially financial and shipping centers. But taking that outside Shanghai would need approval from the central government.

When these policies are allowed elsewhere, will they have been first applied in Shanghai?

Han: That needs approval from the central government, too. People can use their imaginations. But I am emphasizing only the twenty-eight square kilometers.

Why twenty-eight square kilometers?

Han: Because these were the bonded areas approved by the central government—four bonded areas and one management commission. Putting them all together, we got twenty-eight square kilometers.

These bonded areas have a solid foundation. One was the first created after China’s reform and opening up period started, and counts for more than fifty percent of all revenues and tax income from the more than one hundred bonded areas across China. Bonded areas are operating outside the custom. They have a rich history and are in the right place for the pilot FTZ. If we put this in a new area, things would get complicated.